Introduction
In the early days of decentralized finance (DeFi), liquidity provision was largely passive. Users deposited tokens into liquidity pools, and smart contracts automatically spread that liquidity across all possible price levels. This design, known as the standard Automated Market Maker (AMM), was simple and accessible—but far from capital efficient.
To visualize this, imagine you are selling bottled water. Under a traditional AMM model, you would be required to open a store every mile along a nationwide highway, including long stretches where almost no one ever drives. Resources are deployed everywhere, even in places where demand rarely exists.
Concentrated Liquidity Market Maker (CLMM) fundamentally changes this approach. Instead of distributing liquidity evenly across the entire price range, CLMM allows liquidity providers to allocate their capital only within specific price ranges where trading activity is most likely to occur.
In this analogy, CLMM lets you open your stores only along the busiest sections of the highway—where traffic is highest and transactions actually happen. By concentrating liquidity where it matters most, CLMM significantly improves capital efficiency while preserving the core principles of decentralized market making.
What is Concentrated Liquidity?
Simply put, concentrated liquidity refers to liquidity that is allocated within a custom-defined price range, rather than being spread evenly across all possible prices.
In earlier AMM designs—such as those used in Uniswap V2—liquidity was distributed uniformly across the entire price curve. While this approach was straightforward, it resulted in low capital efficiency. A large portion of the assets in the pool was never actually used for trading, especially in pairs with relatively stable prices, such as stablecoin trading pairs.
With CLMM models, such as those introduced in Uniswap V3, this limitation is addressed directly. CLMM allows liquidity providers to deploy their capital only within specific price ranges of their choosing. For example, instead of providing liquidity across all prices, a provider can choose to supply liquidity exclusively for a stablecoin pair between $0.99 and $1.01.
By doing so, liquidity becomes “concentrated” around the current market price—where trades are most likely to occur. This is the core idea behind CLMM: focusing capital where it is actually needed, rather than spreading it thin across inactive price levels.
How Does CLMM Work?
At a structural level, CLMM introduces several key design changes that allow liquidity to be concentrated rather than evenly distributed.
Ticks
To support custom price ranges, CLMM divides the entire price spectrum into small, discrete segments known as ticks. You can think of ticks as boundary markers that separate different price zones.
When creating a liquidity position, a provider must choose a lower tick and an upper tick. These two ticks define the exact price range within which the liquidity will be deployed. Outside of this range, the position no longer participates in trading.
Active Liquidity
In a CLMM system, liquidity is only considered active when the current market price falls within the selected price range.
As long as the price remains between your chosen lower and upper ticks, your liquidity is actively used by traders, and you earn trading fees. However, if the price moves above or below these tick boundaries, your position becomes inactive. When this happens, your liquidity stops earning fees until the price returns to your selected range.
This mechanism ensures that only liquidity positioned near the market price is used for trading.
Capital Efficiency
The most significant advantage of CLMM is improved capital efficiency. Because liquidity providers no longer need to spread capital across price levels far away from the market price, the same amount of trading activity can be supported with much less total capital.
For example, by concentrating liquidity within a narrow price range, a user providing $1,000 in a CLMM position may earn the same daily trading fees as someone who would need to provide $5,000 in a traditional AMM pool. The capital is simply being used more effectively, rather than diluted across inactive price zones.
CLMM Risks
While CLMM can offer higher potential returns, it is also more complex and demanding than standard AMM models. Liquidity provision under CLMM requires ongoing attention rather than passive participation.
Price Moving Outside the Range
If the market price moves outside your selected range, your liquidity position becomes fully converted into one of the two assets and remains idle. During this period, the position no longer earns trading fees. Fee generation only resumes once the price re-enters your range or after you manually adjust your position.
Impermanent Loss
Because liquidity is concentrated within a narrow price range, the impact of price movements is amplified. If the market moves against your position, impermanent loss can accumulate faster than in a standard AMM pool where liquidity is spread across a wider range.
Operational Complexity
Standard AMM pools are relatively simple to manage—you deposit assets and let the protocol handle the rest. CLMM, by contrast, requires market analysis and strategic decision-making. Some liquidity providers actively adjust ranges, while more advanced users may even apply game-theoretic strategies and frequently rebalance positions in response to market conditions.
Summary
Concentrated liquidity market makers deepen liquidity and improve efficiency across DeFi markets. Traders benefit from tighter pricing, while liquidity providers gain the opportunity to enhance capital returns. However, CLMM transforms liquidity provision from a passive yield mechanism into an active investment strategy.
For DeFi newcomers, it is generally advisable to start with small positions or continue using standard AMM pools. Once you have a solid understanding of CLMM concepts—such as price ranges and ticks—you can gradually explore more advanced liquidity strategies with greater confidence.